Photo: Matt Kowal at www.flickr.com
I believe that continued historically-low interest rates and highly volatile equity markets are going to result in millions of today’s retirees being forced to go back to work or to become dependent on the government. I refer to this as the Great Retiree Crisis and retirees must take action now to prevent this from happening.As a Certified Financial Planner, I am aware of the importance that a financial plan has in achieving ones financial goals. A plan, though, is only as good as the assumptions it is based on and it is this element that may prove to be the Achilles’ heel for today’s retirees and those at or near retirement. The financial planning community has largely relied on assumptions regarding equity, debt and inflation percentages that have been experienced over the last 30 years.
There are 3 problems with these assumptions:
- Equity returns the last 30 years have been extraordinarily high as a result of the longest and greatest Bull market in the history of U.S. stock markets. Accordingly, many financial plans used projections that assumed equity returns of 8-10% a year.
- Debt returns over the same period are equally skewed. Remember the double-digit interest rates of the 1980’s? In 1989, as a young broker, I was selling 30-year TVA bonds yielding 10%! Financial plans the last 5-10 years have used interest rate assumptions around 5-6% a year.
- The scenarios that led to the historic markets the last 30 years are very unlikely to EVER be repeated in today’s retiree’s lifetime. And those who are taking distributions based on these outdated assumptions may soon run out of money.
For instance, let’s assume that someone retired 5 years ago at age 60 with a $500,000 investment portfolio. Based on financial plans popular at that time, the retiree is taking $2500 a month in distributions—money they need to maintain their current standard of living. Since the plan anticipated the ability to average a 7% return on a portfolio with close to 50% in equities, the retiree expects to be able to take those distributions and never run out of money.
Adjusting those assumptions based on what many believe resembles more reasonable assumptions going forward requires decreasing the rate of return assumption for a similar-risk portfolio to around 4% and increasing the inflation assumption from 1-2% a year to 3-4% a year (which may still be too conservative). Suddenly, the portfolio that should last forever is now projected to be exhausted in only 16.8 years! That means that the entire nest egg and what it earns cannot sustain the current withdrawal rate. Since the retiree started the withdrawals five years ago, now they are down to 11.8 years—running out of money around age 76!
What about those that weren’t able to set aside a $500,000 nest egg? Or those that have much larger nest eggs but also a higher current standard of living?
It is vital that today’s retirees recognise the need for focused statistical analysis of their retirement income plan so that they can get the facts about the sustainability and outlook for their income in the current marketplace. in my opinioni, many will need to adjust their standard of living (some significantly) in order to bring their retirement income plan back into balance.
The Great Retiree Crisis looms…those who take action now will be the ones most able to survive and thrive.
Common Sense Advisors does not offer investment advice via this medium. Under no circumstance whatsoever do these postings, opinions, charts, or any other information represent a recommendation or personalised investment, tax, or financial planning advice.
Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity.
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